Modelling the mainstream by Fine and Rodrik

When the forecasts of Keynesian economics were exposed by the stagflation of the 1970s, mainstream macroeconomics reversed back into what was called ‘microeconomic foundations’, or the so-called Lucas critique.

Outside intervention into the market was no longer justified by theory. Uncertainty and irrational expectations, part of Keynesian thought, were replaced with ‘rational expectations’ in a myriad of Dynamic Stochastic General Equilibrium models. DSGE models had equilibrium because they started from the premise that supply would equal demand ideally; they were dynamic because the models incorporated changing behaviour by individuals or firms (agents); and they were stochastic as ‘shocks’ to the system (trade union wage push, government spending action) were considered as random with a range of outcomes, unless confirmed otherwise).

Mainstream Keynesian economics now concentrated on explaining ‘business cycles’ or ‘fluctuations’ in an economy using ‘modern’ techniques of modelling. Econometric analyses like the Phillips curve were ditched because such ‘correlations’ between employment and inflation had been proved wrong. The job now was not to look at macro or aggregate data but to work out some ‘model’ that started with some premises of agent (consumer) behaviour or preferences and then incorporated some possible ‘shocks’ to the general equilibrium of the market and then considered the number and probability of possible outcomes.

This is the context of the publication by Professor Ben Fine (with Ourania Dimakou) of two volumes called Microeconomics and Macroeconomics – a critical companion.

Ben Fine is a professor of economics at London’s School of Oriental and African Studies (SOAS). He has been teaching economics for over 40 years and well-known for his excellent Marx’s Capital(written in 1975) and winner of both the Deutscher and Myrdal Prizes in political economy in 2009. Fine is also a prominent organiser of the International Initiative for Promoting Political Economy (IIPPE) which brings together economics scholars critical of mainstream economics and exponents of heterodox alternatives. Dimakou is a lecturer at SOAS with Fine.

Building on his years of experience in teaching mainstream economics, in these two volumes, Fine delivers a comprehensive critique of all mainstream economic theories and models. This makes it an invaluable antidote to the conventional poison of marginalism and general equilibrium theory in microeconomics; and Say’s law and the denial of crises or slumps in macroeconomics.

I am fully reviewing Fine’s books elsewhere (to be announced), but here I want to consider what Fine says about mainstream economic models. Fine makes the point that macroeconomics has shifted from theory to models. Mathematical models replaced theory, with models to be tested ex-post. For Fine, what is wrong with mainstream modelling is the lack of realism in the starting assumptions. Fine goes through the famous accelerator-multiplier Keynesian model that shows the instability of capitalism but does not show why. Fine goes onto analyse the counter-revolution against Keynes’ more radical model of instability and how the mainstream has castrated that into a model that moves to equilibrium given the assumptions of falling prices and wages – indeed, a synthesis with neoclassical theory. Growth models were divorced from short-run fluctuation models.

We can contrast Fine’s view of economic models and their limitations with that of mainstream economist , Dani Rodrik, in his new book, Economics rules.The subtitle tells the story: “why economics works, when it fails and how to tell the difference.” For Rodrik, models are the strength of economics (but also its Achilles heel). They are also what makes economics a science. Rodrik rejects the view that economics can provide “universal explanations or prescriptions”. All mainstream economics can do is “map bits of economic reality”. In other words, economics is not ‘political economy’ in the sense of classical economists and Marx.

Rodrik clearly differs from Fine, who reckons models have become a diversion from proper ‘theory’, which can be tested empirically. Fine rejects the view of Rodrik that the “macroeconomy can be readily and easily modelled in ways that allow more or less complex and knowable policy levers to be deployed” on the basis of ‘rational behaviour’ of ‘representative agents’.

Fine sums up his critique of mainstream economics as “to present and to challenge how macroeconomics has been constructed and has evolved, drawing upon two themes – its convergence upon general equilibrium and macroeconomics and the relationship between the short and long runs”. The goal “of modelling the economy is fundamentally misconceived… a model of the economy is not the economy itself”. For Fine, mainstream mathematical theory is “unfit for purpose”. Models have a place but “their extreme limitations need to be recognised.” As such, macroeconomics remains divorced from the real economy.

DSGE models reduce complex questions to overly simple “hypothesis tests” using arbitrary “significance levels” to “accept or reject” a single parameter value. In contrast, the practical statistician needs a sound understanding of how baseball, poker, elections or other uncertain processes work, what measures are reliable and which not, what scales of aggregation are useful, and then to utilize the statistical tool kit as well as possible. You need extensive data sets, preferably collected over long periods of time, from which one can then use statistical techniques to incrementally change probabilities up or down relative to prior data.

Indeed, we do not have to accept the Lucas critique about statistical analysis. The Bayesian approach, named after the 18th century minister Thomas Bayes who discovered a simple formula for updating probabilities using new data. The essence of the Bayesian approach is to provide a mathematical rule explaining how you should change your existing beliefs in the light of new evidence. In other words, it allows scientists to combine new data with their existing knowledge or expertise.

Bayes law shows the power of data or facts over theory and models. Neoclassical mainstream economics is not just ‘voodoo economics’ because it is ideologically biased, an apologia for the capitalist mode of production. But in making assumptions about individual consumer behaviour, about the inherent equilibrium of capitalist production etc, it is also based on theoretical models that bear no relation to reality: the known facts or priors. In contrast, a scientific approach would aim to test theory against the evidence on a continual basis, not just to falsify it (as Karl Popper would have it) but also to strengthen its explanatory power.

“For Fine, what is wrong with mainstream modelling is the lack of realism in the starting assumptions”:
1) Surprisingly the book on macroeconomics by Fine & Dimakou (the other one is solely by Fine) cites an article by Tony Lawson but seems to ignore his substantial books & those of other critical realists, all based on the ontological & epistemological arguments presented by Roy Bhaskar since 1975 (please see Google Books). Does anyone know why?
2) For putative scientists much more relevant than assumptions (however plausible) is the identification & description of causal determinants, which necessarily vary in their abstraction-concretion. The heuristic method here is abstraction, & it was practised by Marx. Bhaskar & other critical realists, notably Andrew Sayer & Margaret Archer, have developed this approach.
3) By contrast, Andrew Brown, drawing on the arguments of Evald Ilyenkov, has tried to show that a kind of Marxist argument is more veridical than the best critical realist one:http://www.aworldtowin.net/msf/msf/ideas%20and%20philosophy/abrown.PDFhttp://aworldtowin.net/resources/andrewbrown.html (on a single webpage so perhaps easier to read)

Look forward to your further elaboration. It is clear that the growing economic crisis is setting a challenge to “modern economics” equivalent to the crisis of Keynesian in the 1970s that you point out. We need to criticise ruthlessly neo-classical economics and its mantra of marginalism but we also have to develop the Marxist understanding of the dynamics of capitalism alongside this. In my recent posting on the planningmotive.com I have introduced turnovers to the organic composition of capital and this modification ties it closer into the movement of the rate of profit. Data, categories and assumptions are vital to developing our understanding of what is happening presently in the capitalist economy. All tyrants and exploiters need their soothsayers to predict the future. The role of the modern economist is no different to the astrologer of old. Neither can predict what is to come and neither can explain what has passed before.